T-2057-72
Aluminum Company of Canada Limited
(Plaintiff)
v.
The Queen (Defendant)
Trial Division, Heald J.—Ottawa, February 12
and 18, 1974.
Income tax—Plaintiff's subsidiary, source of raw materi-
al—Subsidiary required to pay increased income taxes—
Plaintiff voluntarily reimbursing subsidiary—Deduction from
income claimed by plaintiff—Rejected by Minister as capital
expenditure—Appeal allowed—Income Tax Act, sec.
12(1Xa).
The plaintiff corporation manufactured aluminum from
alumina, obtained through Alcan Jamaica Limited (Aljam) a
Jamaican corporation and a wholly owned subsidiary of the
plaintiff since 1958. On cancellation of a contract between
the plaintiff and C corporation for the supply of alumina, the
sum of $3.6 million in compensation became payable by C
to the plaintiff, over a term of years. The Government of
Jamaica, deeming itself entitled to a share of the compensa
tion, required Aljam to pay it in the form of increased
income taxes. The plaintiff reimbursed Aljam for the addi
tional taxes paid, not as a legal obligation, but as a "practical
and business decision". The plaintiff's claim for deduction
from its income of the amount so paid was rejected by the
Minister as being an outlay on capital account.
Held, allowing the appeal, the expenditure was incurred in
the process of operating a profit-making organization; as
such it was an expenditure on revenue account, and there
fore deductible.
British Insulated and Helsby Cables, Ltd. v. Atherton
[1926] A.C. 205 and Associated Investors of Canada
Ltd. v. M.N.R. [1967] 2 Ex.C.R. 103, considered;
Canada Starch Co. Ltd. v. M.N.R. [1969] 1 Ex.C.R. 96
and Hallstrom's Pty. Ltd. v. Federal Commissioner of
Taxation (1946) 72 C.L.R. 634, applied; Pigott Invest
ments Limited v. The Queen [1973] C.T.C. 693 and
Olympia Floor & Wall Tile (Quebec) Ltd. v. M.N.R.
[1970] Ex.C.R. 274, followed.
INCOME tax appeal.
COUNSEL:
Bruce Verchère and Marc A. Leduc for
plaintiff.
Alban Garon, Q.C., and Louise Lamarre-
Proulx for defendant.
SOLICITORS:
Stikeman, Elliott & Co., Montreal, for
plaintiff.
Deputy Attorney General of Canada for
defendant.
HEALD J.—The plaintiff carries on, inter alia,
the business of manufacturing and selling alumi
num and aluminum products. It is a fully inte
grated aluminum company. Aluminum is made
from alumina (the oxide of aluminum) by means
of a smelting process. Alumina is a refined
mineral ore derived from ore which is found in
the ground and known as bauxite.
One of the major world sources of bauxite is
Jamaica, West Indies. In order to investigate the
commercial potential of Jamaican bauxite,
Alcan Jamaica Limited (hereafter Aljam) was
formed under Jamaican law in 1943. Since
1958, Aljam has been a wholly owned subsidi
ary of the plaintiff. Aljam subsequently
explored for and acquired by lease substantial
ore deposits in Jamaica containing a commercial
grade of bauxite. Aljam also operates two proc
essing plants in Jamaica, for the conversion of
bauxite to alumina.
In April 1954, the plaintiff and Aljam entered
into an agreement under which it was agreed
that the plaintiff would acquire alumina from
Aljam in exchange for aluminum which alumi
num would be sold by the plaintiff for Aljam's
account. By the 1960's, Aljam had become a
very important source of alumina for the
plaintiff.
In January 1957, the plaintiff entered into an
agreement with Canadian British Aluminum
Company Ltd. (hereafter Canbaco) whereby
plaintiff agreed to supply alumina to Canbaco in
exchange for aluminum at a ratio of 6.285 units
of weight of alumina to 1 unit of weight of
aluminum. Canbaco was a wholly owned sub
sidiary of the British Aluminum Company and
had just established a plant in Quebec. The
plaintiff and Canbaco are competitors, there is
no common ownership of shares. Accordingly,
this transaction was an arm's length transaction.
The two agreements above described were
barter agreements. Barter agreements in the
aluminum industry came into use in the late
1950's and early 1960's because, at that time,
there was no established market price for alumi-
na. The purchasers of alumina could only relate
its value to the value of the finished product,
aluminum. As a result, barter contracts were
utilized. Barter contracts at this point in time
generally provided for a ratio of 6i to 7 tons of
alumina to 1 ton of finished aluminum product.
The Canbaco agreement was for a term of 20
years commencing in 1958. Under the agree
ment, the plaintiff was obliged to supply and
Canbaco was obliged to take, for the year 1958,
47,500 long tons (2,240 lbs.) of alumina and, for
each of the years 1959-1977, 120,000 long tons
of alumina. In case of cancellation of the agree
ment or in the case of a decrease in the quantity
of alumina required by Canbaco, Canbaco was
obliged to pay the plaintiff $6 for each long ton
per year by which the quantity of alumina was
decreased, said payment to be made on January
1 in each of the five years beginning with that in
which cancellation took effect.
The agreement was cancelled by Canbaco in
1961 who paid to the plaintiff, as per the agree
ment, as compensation during the years 1962-
1966 inclusive, equal instalments of $720,000
(calculated as described in the next preceding
paragraph). In computing its income for its
1962-1966 taxation years inclusive, the plaintiff
included the amounts so received by it from
Canbaco, and, in particular, in 1966, it included
the said instalment of $720,000 in its income.
In letters written to Aljam on September 18
and September 25, 1964, Government officials
in Jamaica made known to Aljam their view that
Aljam was entitled to share in the $3,600,000
compensation being paid by Canbaco to the
plaintiff following cancellation of the contract
above referred to and that the Jamaican Gov-
ernment was entitled to include in Aljam's
income, and thus tax under Jamaican income
tax laws, some portion of the said $3,600,000
being paid by Canbaco to the plaintiff in the
years 1962-1966 inclusive. In both letters, the
Jamaican officials also referred to the disparity
between the price at which Aljam contracted to
barter its alumina to Alcan and the price at
which the plaintiff sold Jamaican alumina to
independent contractors in arm's length transac
tions. In the letter of September 25, 1964, the
opinion is also expressed that the commission
paid by Aljam on the sale of the aluminum
received by it under the barter contract with the
plaintiff appeared to be excessive. This commis
sion was paid to companies associated both with
the plaintiff and with Aljam. This letter goes on
to comment that the problems above referred to
adversely affected the Jamaican revenue and
said further that the Government of Jamaica
intended to apply the provisions of section 32(3)
of the Income Tax Law of Jamaica to rectify
the situation. Said section 32(3) appears on page
35 of the Book of Documents tendered in evi
dence with the consent of both counsel. It reads
as follows:
32-(3) Where a non-resident person carries on business with
a resident person, and it appears to the Commissioner that
owing to the close connection between the resident person
and the non-resident person the course of business between
those persons can be so arranged and is so arranged, that the
business done by the resident person in pursuance of his
connection with the non-resident person produces to the
resident person either no profits or less than the ordinary
profits which might be expected to arise from that business,
the non-resident person shall be assessable and chargeable
to tax in the name of the resident person as if the resident
person were an agent of the non-resident person.
The said letter of September 25, 1964 (a
lengthy letter containing some 9 pages in all)
then proceeds to detail the reasons why the
Government of Jamaica felt justified in applying
said section 32(3) to the circumstances of this
case. In summary, the position of Jamaica was,
that while Aljam was not a party to the Canbaco
agreement, that because Aljam was a wholly
owned subsidiary of the plaintiff and because
Aljam contributed substantially to the perfor
mance of the Canbaco agreement before cancel-
lation, that by virtue of said section 32(3), Ja-
maica was empowered to, in effect, "look
through" the contract, to see what profits, if
any, arising from the Canbaco cancellation were
applicable to Jamaica. On page 4 of the letter of
September 25, 1964, the Jamaican Commission
er of Income Tax said:
... I would not be fettered by a contract between a com
pany and its wholly owned subsidiary. In the first place it is
the right hand contracting with the left... .
The letter then proceeds to consider the extent
to which Jamaica has suffered from the cancel
lation of the Canbaco contract and to project
and estimate the portion of the Canbaco con
tract which would have been filled from plain
tiff's supply of Jamaican alumina and concludes
by stating that said portion would have risen to
at least 75%. Accordingly, the letter advises
Aljam of the intention of the Government of
Jamaica to assess and charge income tax on
75% of the $3,600,000 cancellation payments,
i.e., the sum of $2,700,000 was going to be
deemed the portion of the profits applicable to
Aljam and thus taxable in the hands of Aljam
under Jamaican law.
Following receipt of this letter, Aljam's offi
cials consulted their lawyers who advised them
that the Income Tax Commissioner did indeed
have the powers claimed by him in his letter of
September 25, 1964; that, additionally he had
power to subpoena the books and records of the
foreign parent of a Jamaican corporation. Fur
ther meetings and discussions ensued between
officials of the Jamaican Government and offi
cials of Aljam. The Jamaican tax problem was,
of course, reported to the senior officers of the
plaintiff in Montreal. In August of 1965, Mr. J.
G. Stark, who had been the Treasurer of Aljam,
resident in Jamaica, returned to Montreal to
take up new duties with the plaintiff. At that
time, he reported to his superiors that, in his
opinion, while the initial Jamaican claim was
based on specific and individual technical tax
claims, that as the negotiations and discussions
continued, it became clear to him that, in reality,
the claim of the Jamaican authorities was a
persistent claim for more tax revenues general
ly. He said that each year the scope of their
demands broadened and increased. After dis
cussions with the other senior management per
sonnel of the plaintiff in Montreal, Mr. Stark
was sent back to Jamaica to attempt a settle
ment of Aljam's tax problems with the Jamaican
Government. As a result, a settlement was
effected in February of 1966, covering the taxa
tion years 1963-1966 inclusive. Under the terms
of the settlement, Aljam was assessed an addi
tional 735,000 Jamaican pounds in income tax.
Mr. Stark, in his evidence gave these reasons
for settlement:
1. To preserve a supply of vital raw ma
terial. It was his view that the dispute might
well become quite acrimonious, thus jeopard
izing the plaintiff's interests in Jamaica. It
was his view that if Aljam took a legalistic
position, and resisted the proposed assess
ment, that the Jamaican Government had
other avenues of approach open to it. Thus,
taking a pragmatic approach, on the basis of
sound business judgment, he recommended
the settlement.
2. From an accounting and a commercial
point of view, he observed that the contingent
tax liability to Jamaica had to be shown in the
company's annual financial statements. He
said that this contingent liability seemed to be
growing each year as the tax demands of
Jamaica escalated. He feared that if this con
tingent tax liability continued to grow, the
point would soon be reached where it might
well impair the plaintiff's ability to carry on
its foreign business operations.
Mr. Robert J. Moyse, the plaintiff's Treasurer
until January 1, 1966, said he approved this
settlement because, firstly, he felt the Govern
ment of Jamaica had a strong moral, if not a
strong legal position because the Jamaican
alumina represented a large portion of plaintiff's
alumina supply at that time. It seemed to him
"that the Jamaican authorities were determined
to get the price of alumina increased" after
participating in some of the meetings there. It
was his impression that while the Canbaco
matter and the four other specific income tax
matters discussed played a part in the position
taken by Jamaica, the situation really crystal
lized to the point where one fact emerged, i.e.,
Jamaica was determined, one way or the other,
that Aljam was going to have higher taxable
income. He felt that the Canbaco compensation
and the other specific matters were simply
devices to obtain a higher price for Jamaican
alumina. Mr. Moyse also expressed the view
that if the supply contract between the plaintiff
and Aljam had been an arm's length transaction,
it was quite likely that said contract would have
contained a compensation clause similar to the
one in the arm's length agreement between Can-
baco and the plaintiff. He accordingly felt that
Jamaica's claim to a portion of the Canbaco
compensation was well founded.
On March 31, 1966, Aljam wrote to the plain
tiff reporting the settlement with the Jamaican
tax authorities above referred to and invoicing
the plaintiff for "your pro rata portion of the
said additional selling price of alumina and the
portion of the Canbaco cancellation payment
deemed payable to us, as determined by the
Jamaican authorities and accepted by us for
purposes of the settlement". The attached
invoice thus contained two items. The second
item of the invoice reads as follows:
Portion of Canbaco cancellation payment payable to Aljam
as determined by the Income Tax Appeal Board of Jamaica
£480,055.
(The reference to the Income Tax Appeal Board
of Jamaica is because said Board, in effect,
ratified the settlement between the parties by a
letter dated March 9, 1966 to Aljam's counsel
thus disposing of the appeal to said Board
launched earlier by Aljam).
The said sum of 480,055 Jamaican pounds
amounted to $1,447,078 in Canadian dollars
which sum the plaintiff promptly reimbursed to
Aljam. Mr. Nathaniel B. Davis, the plaintiff's
Chief Executive Officer at the time, described
the plaintiff's action in reimbursing Aljam as
being "an act to make whole the income of
Aljam". He described the plaintiff's decision as
a pragmatic decision. He felt it was in the plain
tiff's best long-term interests to settle the dis
pute, that a protracted dispute in the Courts
would have "tended to harden the relation
ships" between the Jamaican Government and
the plaintiff. Other officials of the plaintiff con
firmed his view that it was perfectly proper for
the plaintiff to reimburse Aljam. Mr. William J.
Reid, plaintiff's Treasurer after January 1, 1966,
said that the plaintiff's management looked on
this charge as a pricing adjustment more than
anything. He said similar retrospective adjust
ments were not uncommon. He gave two exam
ples of contracts which plaintiff had with other
firms for the supply of petroleum coke. In those
cases, the contracts were re-negotiated because
the contract price subsequently differed
markedly from the fair market value. He said
that viewed as an adjustment to alumina prices,
the $1,447,078 payment had the effect of
increasing the alumina price to $59.46 per short
ton from $58.81 per short ton and that the said
price of $59.46 per short ton was well within
the fair market value of alumina during the
period in question. He added that said price was
well below prices paid by the plaintiff for alumi-
na in arm's length transactions.
The plaintiff, in its records, included the said
sum of $1,447,078 as a cost of sales which
procedure was concurred in by its auditors.
The defendant, in assessing the plaintiff for
its 1966 taxation year, disallowed the said ex
penditure of $1,447,078.
It is the defendant's position that subject ex
penditure constitutes a payment on account of
capital. In support of this position, the defend
ant refers to the evidence of the plaintiff's offi
cials to the effect that said expenditure was
made to preserve a supply of vital raw material,
thus it was expended to maintain and continue
in existence a capital asset and is thus an outlay
on account of capital. The cases of British
Insulated and Helsby Cables, Ltd. v. Atherton'
and Associated Investors of Canada Ltd. v.
M.N.R. 2 are cited in support of this submission.
I do not so interpret the effect of either of said
cases. In the Associated Investors of Canada
Ltd. case (supra) President Jackett (as he then
was) said at page 103:
The general concept is that a transaction whereby an endur
ing asset or advantage is acquired for the business is a
capital transaction (See British Insulated and Helsby Cables,
Ltd. v. Atherton [1926] A.C. 205.)
Both of these cases define a capital transaction
as one whereby an enduring asset or advantage
is acquired for the business (italics mine). Thus,
in my view, the above authorities are not
authorities in support of a submission that
monies expended for the maintenance and con
tinuation of a capital asset are outlays on
account of capital. Furthermore, on all of the
evidence adduced, I have concluded that the
true nature of subject expenditure was a pricing
adjustment to the cost of raw material pur
chased by the plaintiff and required by it in its
business of manufacturing aluminum. This was
not uncommon in this type of business. Even
after said adjustment, plaintiff's cost of raw
product was well within the fair market value
range. As a pricing adjustment to the cost of
raw material, it did not involve any addition to
or withdrawal from fixed capital and was, thus,
in my view purely a working expense.
The distinction between outlays on revenue
account and on capital account was succinctly
1 [1926] A.C. 205.
2 [1967] 2 Ex.C.R. 96.
stated by President Jackett (as he then was) in
the case of Canada Starch Co. Ltd. v. M.N.R. 3
where he said:
In other words, as I understand it, generally speaking,
(a) on the one hand, an expenditure for the acquisition or
creation of a business entity, structure or organization, for
the earning of profit, or for an addition to such an entity,
structure or organization, is an expenditure on account of
capital, and
(b) on the other hand, an expenditure in the process of
operation of a profit-making entity, structure or organiza
tion is an expenditure on revenue account.
Applying those tests to the circumstances in
the case at bar, I am satisfied that subject
expenditure was incurred in the process of oper
ating a profit-making organization and, as such,
was an expenditure on revenue account. Plain
tiff is an integrated aluminum company exten
sively involved in aluminum production from
the beginning where the raw ore (bauxite) is
mined to the final stages where the finished
product, aluminum, is produced, marketed and
sold. Its Jamaican subsidiary was faced with
demands from the Jamaican Government which
result in an upward adjustment of the price of
raw product required by the plaintiff for the
satisfactory operation of its entire profit-making
organization. Thus, the plaintiff and its subsidi
ary, Aljam, made a business decision to
acquiesce in said upward price adjustment in
the cost of its raw material.
As was stated in Hallstrom's Pty. Ltd. v.
Federal Commissioner of Taxation 4 , the solu
tion "depends on what the expenditure is cal
culated to effect from a practical and business
point of view rather than upon the juristic clas
sification of the legal rights, if any, secured,
employed or exhausted in the process."
In this case, the plaintiff made a "practical
and business decision" because the Jamaican
request was reasonable and justified in all the
circumstances and because it desired to ensure
a continuance of its friendly relations with a
host country.
3 [1969] 1 Ex.C.R. 96 at page 102.
4 (1946) 72 C.L.R. 634 at page 648.
The situation here is not unlike that con
sidered by Noël A.C.J. in Pigott Investments
Limited v. The Queens where it was held that
the amounts expended by the plaintiff were one
facet of a commercial transaction the object of
which was to earn income from its construction
business. The subsidiary in effect became the
mere agent of the plaintiff and the expenses of
the agent were those of the principal.
Defendant's counsel further submitted that
since there was no legal obligation on the plain
tiff to turn over to Aljam a portion of the
Canbaco compensation, it was accordingly not a
properly chargeable expenditure against the
plaintiff's income. The jurisprudence does not
support this submission. The authorities clearly
indicate that an expenditure made as a "gift" or
as a matter of commercial morality will be
allowed as a deduction in computing income 6 .
Subject expenditure was made in the interests
of commercial morality (because of the strong
moral entitlement of Jamaica) and to preserve
the image of the plaintiff as a good corporate
citizen of Jamaica through its Jamaican subsidi
ary, Aljam.
For all of the above reasons, I have conclud
ed that subject expenditure of $1,447,078 was
properly deducted from income by the plaintiff
in the taxation year 1966, the year of payment.
The appeal will therefore be allowed with
costs. The plaintiff's assessment for the taxation
year 1966 will be referred back to the Minister
for reassessment not inconsistent with these
Reasons.
5 [1973] C.T.C. 693.
6 See: Olympia Floor & Wall Tile (Quebec) Ltd. v. M.N.R.
[1970] Ex.C.R. 274 and Pigott Investments Limited v. The
Queen (No. 5 above).
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.